Aerie Pharma: Bullish Thesis Intact

Summary

Aerie recently reported positive topline data for Mercury 1.

The company quickly raised cash and removed any financing overhang.

My updated valuation model is provided.

Mercury 1

It's nice when everything actually goes according to plan. Just as I predicted, Aerie Pharmaceuticals' (NASDAQ:AERI) Roclatan hit it out-of-the-park with the top line readout of its Mercury 1 trial. Not only was it statistically superior at all 9 time points versus latanoprost and Rhopressa, but it sported an absurdly low p value of less than 0.0001. That's right, it took 4 decimal places just so that the p value could be reported to a single significant digit.

Throughout the first 3 months of dosing, Roclatan was superior by 1.3-2.5 mmHg and 1.8-3.0 mmHg to latanoprost and Rhopressa, respectively. Considering that the Optometric Clinical Practical Guideline reports that there is an 11% increase in risk for every 1 mmHg increase of IOP, Roclatan cuts the risk of further optic nerve damage by 14.3-27.5% compared to latanoprost alone.

This is significant because it is achieved with a single eye drop dosed once daily, compared to the other adjunctive prescriptions that require dosing 2-3 times per day. Additionally, based on how well Rhopressa was shown to perform over a 12-month time period, I expect Roclatan will similarly shine. Whether this ultimately means that Rhopressa (and by extension Roclatan) is shown to be disease modifying is not yet settled, but that moon shot scenario is still alive.

Moving on to the safety data from Mercury 1, nothing unexpected popped up. Yes, there was a much higher discontinuation rate of 15.5% and 17.6% for Roclatan and Rhopressa compared to just 5.5% for latanoprost, but it's important to remember a few key details: (1) given the high baseline IOPs of the patients entering the trial, a majority of the patients were already using latanoprost or another PGA, and therefore less likely to discontinue. And (2) patients with known contraindications or hypersensitivity to latanoprost were not enrolled in the trial. This is going to naturally skew the safety results to make latanoprost appear much more favorable than in a real world setting.

As expected, hyperemia (red eye) was the most common adverse event at roughly 50% of the patients, with similar rates seen in the Rhopressa Rocket 1 & 2 trials. This indicates that latanoprost was not additive to the hyperemia rate, in-line with expectations that management has previously asserted. Additionally, management noted on the conference call that hyperemia was mild and sporadic for a large majority of the patients, with only 10% of the patients in the Rocket trials experiencing it at each visit.

Lastly, a very important piece of data seems to be going under the radar. Given that Mercury 1 consisted of 3 arms (Roclatan, Rhopressa & latanoprost), a head-to-head comparison of Rhopressa and latanoprost showed that Rhopressa was non-inferior to latanoprost at baseline IOP less than 25 mmHg. This means that Rhopressa has now been shown to be non-inferior to both timolol and latanoprost for baseline IOP less than 25 mmHg, which is when a large majority of patients are initially diagnosed with glaucoma.

This is significant because the lack of systemic side effects and ability of Rhopressa to restore the natural drainage pathway within the eye is beginning to make Rhopressa look like a first line agent.

Financial Position and Valuation

Not surprisingly, Aerie management was quick to raise cash following the spike in the share price, although I must admit a little more aggressive than I had originally anticipated. To summarize:

After June 30, 2016 and prior to the Mercury 1 readout, Aerie sold 2.54 million shares for $45.3 million with its at-the-market ("ATM") program.

With its ATM authorized immediately following the Mercury 1 readout on September 15, Aerie sold 1.52 million shares for gross proceeds of $50 million.

On September 16, Aerie announced an upsized public offering of $75 million at $29.50 per share.

Taken all together, Aerie raised almost $170 million in cash during the quarter, while adding about 6.6 million shares to its outstanding count. Based on my estimates, the company will end the quarter with about $255 million of cash and equivalents, and a share count around 33.5 million. Assuming conversion of the convertible notes adds another 5 million shares, the total is now up to over 38.5 million, as opposed to the 35 million I originally assumed.

Adding in an allowance for stock options and employee grants, I'm now going to assume 40 million shares in my valuation model. This reduces my fair value range to $30-$37.50 using a 20% and 15% discount rate, respectively.

Although a reduction in my fair value range would imply that I'm not happy with management actions, that is certainly not the case. I applaud the Aerie management team for not only keeping to its original schedules for Rhopressa and Roclatan, but also for being very upfront and open about the clinical trial data; particularly after the "failure" of Rocket 1.

Additionally, I can't fault management for aggressively raising cash now, so that it can turn its undivided attention to building out its manufacturing plant in Ireland and finalizing commercialization plans for Europe and Japan.

Concluding Thoughts

Despite the easy comparisons that the stock price will retrace back into the teens like last year after the Rocket 2 readout, I just don't expect that to happen. For one thing, the stock has been significantly derisked with the positive Roclatan data, positive 12-month safety and efficacy data of Rhopressa, and the financing overhang cleared. But the second reason, and even bigger reason in my view, is that there are additional near-term catalysts to support the stock price.

By the end of the year, Aerie expects to finalize its plans for the EU and Japan, which will likely (hopefully) include a partnership and large upfront payment. A partnership would not only provide clarity on when the products can make it to the market, but also as to what type of economic impact it may have on Aerie. Given that my current valuation is for the US only, a significant positive revision may be in the cards.

Disclosure:I am/we are long AERI.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.